Labour’s inflation policy a recipe for disaster

December 28th, 2009 at 3:00 pm by David Farrar

The Dom Post has a guest column by from the :

The idea that New Zealand can ignore and grow faster through easy money and a lower exchange rate is a tempting, but short-sighted view. It ignores the fact that higher domestic prices would ultimately undermine rather than promote international competitiveness. Economic growth and export success must ultimately be built on real factors such as productivity growth, not easy money and exchange rate depreciation.

It is like cheating on an exam – only works for a while

The Reserve Bank’s primary focus on inflation recognises that needs to be based on a single instrument and policy objective. Pursuing multiple objectives with multiple instruments, as now suggests, is a recipe for incoherent policy and poor economic performance such as New Zealand experienced before its path-breaking reforms of the 1980s.

TVNZ is a good example of having multiple conflicting objectives. Either none of the objectives are achieved particularly well, or some of them are just ignored.

It would also undermine the transparency and accountability that were important objectives of the Reserve Bank of New Zealand Act. Under the current framework, the governor of the Reserve Bank is personally accountable for realising the inflation target under a policy targets agreement with the finance minister. Sustained breaches of the inflation target can result in the non-executive members of the Reserve Bank board recommending dismissal of the governor to the minister. This is no idle threat, but it would be difficult, if not impossible, to hold the governor accountable for achieving multiple objectives instead of a clearly defined inflation target.

An excellent point. More objectives will mean less accountability. The Governor will always have a get out of jail card.

Since the first PTA was entered into in 1990, the inflation target has been progressively watered down. Most notably, the inflation target has been relaxed from 0-2 per cent to 1-3 per cent and given a medium-term focus, so there is now greater tolerance of short-term breaches.

I actually believe it should go back to a 0% to 2% range. Over time even 3% inflation is too much.

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21 Responses to “Labour’s inflation policy a recipe for disaster”

  1. reid (15,531 comments) says:

    “I actually believe it should go back to a 0% to 2% range. Over time even 3% inflation is too much.”

    It sure is. Relaxing it was a crazy move, more so in light of the miraculous global conditions pertaining at the time.

    Once again, the Fourth Estate failed to use its considerable resources to play its stated watchdog role but instead sycophantically acquiesced in order to build and retain access to “exclusive govt sources,” standing aside, silent as Liarbore squandered this once in a lifetime opportunity to eliminate 100% of our national debt, which Australia succeeded in doing several years prior to the inevitable crash.

    FFS. What do you editor arseholes have to say for yourselves? Are you at all ashamed in any way?

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  2. Repton (769 comments) says:

    What would happen to the economy if inflation stayed at 0%?

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  3. Jack5 (4,220 comments) says:

    Kirchner wrote:

    …economic growth and export success must ultimately be built on real factors such as productivity growth, not easy money and exchange rate depreciation.

    Then surely it cannot be built either on tight money and exchange-rate appreciation unrelated to trade and current-account deficits, on exchange rates set by speculators (tiny NZ’s currency is among the top 12 traded in the world) and a Reserve Bank’s short-term interest rate policy.

    And how did Japan, Germany, and now China succeed so spectacularly economically with low exchange rates managed either overtly (as in China), or covertly?

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  4. Jack5 (4,220 comments) says:

    I’ve just Googled Kirchner and find he’s a former “Director of Economic Research with Standard & Poor’s Institutional Market Services, based in Sydney and Singapore…”

    The ratings agencies really saw the world financial crisis and the NZ finance-company crises coming, didn’t they?

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  5. Poliwatch (335 comments) says:

    ” What would happen to the economy if inflation stayed at 0%? ”
    0% inflation and =0% productivity growth – we’re OK

    The point here is that productivity growth is the important factor in an economy and not the inflation rate. The problem with a high inflation rate >2% is that you have to have a productivity growth rate higher than that to be getting ahead – NZ does not have a good record at achieving those sort of growth rates.

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  6. Viking2 (10,715 comments) says:

    We’ve been operating under this regime for a few years now and it ain’t been particularly brilliant in its success has it.? Even Dr Don has expressed his doubts.
    Like all one trick ponies they stumble at the first high hurdle. When our economy imports most if its inflation to deny that inflation is an exercise in futility.
    Would it matter if it was 4% and can anyone tell me what the average is for the last 150 years.
    One good example of the stupidity of this approach is Steel most of which is imported.
    Steel last year rose around 85% in price. Almost all of this increase was dictated by the supplying mills offshore and by the freight rates.
    What were we supposed to do. Tell them oh sorry we can only allow you 2% price increase. 2% when there was a world shortage.
    That’s at the same time we managed a similar increase in the selling price of our milk products. Go figure.
    I guess you would all argue that RBNZ should have sent interest rates through the roof. Well that’s exactly what was predicted in March and April and had we not coped the crisis in the States you would all now be paying 14% for your money.
    It amazes me that we allow a private bank to control the NZ economy. That is supposed to be the Govt.’s job.
    At present we have both lots working in a vacuum from one another.
    The Govt. is elected to take responsibility for our standard of living. If they can’t do that they should quit or give the job to someone who can.

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  7. Viking2 (10,715 comments) says:

    We could compare our results with Australia’s. We have fallen how far behind them? From ahead of them in the late 60′s to 35% behind today. Stunning success, by Australia no less.

    They have a total objective rather than a singular mindset.
    And don’t bother with the mining story its about 5% of their economy, much less than our Dairy at 25%

    Economic growth and export success must ultimately be built on real factors such as productivity growth, not easy money and exchange rate depreciation.

    Well he simply states the obvious here but he doesn’t state the obvious cause and that’s Govt. policy in total including welfare, high taxation etc etc. All stuff we have canvassed ad infinitum for the last number of years.

    Worse, he doesn’t bother to exhort this Govt. to think about the issue nor does he support the drive to catch Australia, something which our two top guns ( Smiley and Dopey) have decided is not going to be the goal.
    If something doesn’t to change soon NZ in 15 years will be a place of Maoritocrasy, dairy framers and beneficiaries.
    The rest of us will have moved on.

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  8. reid (15,531 comments) says:

    V2, inflation eats away at you like cancer.

    The inflation question is: is a little bit of cancer OK? If so, how much?

    The issue is, if you allow a little bit as a tolerance as Liarbore has, then what happens if and when the doctor says there’s cancer and there needs to be some surgery and pain to remove it. If the patient says no they’d prefer not thanks anyway, the cancer grows, eventually requiring either major pain or death, as we’ve seen in the latter by Zimbabwe. The longer you leave it the worse it gets and the sensible option is clear to all.

    The problem is the public aren’t educated on this and disgracefully the media allows one set of politicians to get away with prescribing a bad diet for the nation and then even worse, when another set of politicians propose to cure it via the only possible method: spending cuts; the media then criticise that latter set of politicians.

    How fucking stupid is that nevertheless you see it happening in continuous cycles.

    P.S. I may be wrong but thought the doubts expressed by Brash center around the one-weapon approach, not the target itself.

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  9. Chthoniid (1,966 comments) says:

    I think it is important to realise that our peculiar combination of high interest rates/high exchange rates were actually warning signals that we had developed some very significant macro-economic imbalances (current account, household savings). A lot of that was due to conflicts between Labour’s fiscal stance and the RB mandated stance.

    If we look at the examples of Japan and the like- during the periods of very high growth- these were characterised by lower inflation rates than their trading partners and high savings rates (combined with rapid increases in productivity). Fiscal policy moved in sync with monetary policy, and not against it.

    I can’t shake the feeling that Labour’s desire to overturn the RB Act is motivated by the expediency of ‘turning off the warning signals’ when they get control of the Treasury benches again and start screwing the economy up.

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  10. redqueen (342 comments) says:

    Jack5

    The point of this analysis is that artificial means create distortions which, ultimately, come back to haunt us. We have maintained artificially high employment levels, which has resulted in artificially high debt levels now (as have most of the ‘stars’ among the developed countries in the past decade). That we have ‘achieved’ a reduction in the current account recently through an appreciated dollar is case in point: our economy has generated jobs in low-productivity areas, or areas with limited future prospect, and this has hurt the tradeable sectors (whether services or goods). This has been the case for the past decade. Simply maintaining high employment, and with Government jobs offering more than private sector jobs, has been a serious problem and has redirected resources within the economy in a distorted fashion. That we need to have increases in our productivity to achieve growth is like saying, ‘We need to do exercise to be able to run faster’. To say that the solution is liposuction or that we should simply stop eating isn’t how you get in shape. Our economy doesn’t need to be cajoled more, it needs to stop having government see itself as the arbiter of good things happening.

    This doesn’t require a ‘fundamental change’ in attitudes, it doesn’t require mass stimulus, and it doesn’t require cheap money. What we need is to stop seeing the government as the solution, which the Labour Party seems hellbent on continuing, and instead look at what’s gone wrong. To blame imports, or exchange rates, when we have high employment generating income is absurd. We then need to have high interest rates (by international standards) to attract money here and then complain that exchange rates aren’t favourable (even though the money has to be converted to get our rates, which pushes down the price of foreign currencies). This is called ‘living beyond your means’ and is something we do really well. But it’s a macro problem, no matter how much we are told that macroeconomists are the problem by incompetent American economists, and it’s something which we need to solve at that level. If we didn’t ‘keep people spending’, we wouldn’t have this problem, and if we hadn’t built up huge debts we wouldn’t have to have such high interest rates to attract foreign capital.

    So yes, let’s congratule the DomPost on actually reporting a simple, but true, point: productivity needs to rise. That isn’t as hard a proposition as it sounds; it’s just one which governments never seem to understand. I spend quite a bit of my time at work trying to enhance productivity and am often amazed how people don’t see the solutions, not because I am some kind of genius, but because there is still a prevailing ‘can’t do’ attitude about this sort of thing. Given that we’re a society known for its ‘can do’ attitude, this is often perplexing. What I think it comes down to is that we have limited incentives and a prevailing statist mentality that doesn’t make people think achieving more is really worth much. And, in the end, is it really? Whether I improve productivity or not, I probably won’t be recognised and rewarded for it in any meaningful sense. I just do it because I was brought up to improve things.

    So yeah, let’s be more productive and stop trying to ‘influence’ things. The law of unintended consequences is too easily observed.

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  11. Jack5 (4,220 comments) says:

    Viking2′s 5.32 post suggested the dairy industry made up about 25 per cent of NZ GDP – the economy.

    Are you sure of this Viking2? That 25% wouldn’t be the proportion of total exports provided by the dairy industry?

    And re RedQueen’s post at 5.55

    …Let’s congratulate the DomPost on actually reporting a simple, but true, point: productivity needs to rise. …

    Am I hallucinating? I thought that cry had been echoing from the grandstands regularly for the last 10 years or so.

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  12. redqueen (342 comments) says:

    No, as I mentioned, Jack5, while the Government has been banging on about productivity for a decade, it means ‘with its help’ at best and ‘because of it’ at worst. The DomPost didn’t say the solution is the Government, it said the solution was productivity rising. That statement is quantifiable, if productivity rises you’ll see signs of it. A decade of government initiatives and studies has resulted in nothing. So no, I wouldn’t say this cry is an echo of a decade, I’d say it’s finally coming towards the edge of the forest and realising there is such a thing as light, rather than sitting in the forest demanding there be light…

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  13. dave (985 comments) says:

    ” What would happen to the economy if inflation stayed at 0%?

    Well, also, if it bottomed out at zero, any deflation pushing the economy below the target range would lead to negative inflation; the result being that borrowers would be forced to borrow at rates higher than official interest rates, with debt servicing becoming higher. Central banks face the restriction that nominal interest rates cannot fall below zero.

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  14. Viking2 (10,715 comments) says:

    Jack5. yep 25% of our export earnings so probably a goodly % of our GDP as well or at least the productive part of our GDP and that’s what we should measure. Not the banal handout stuff.
    The 5% from Aussie is about its mineral exports. from memory but even if its higher the point still remains as Dr Don pointed out its not the be all and end all for the Aussies.
    They still have a huge farming based economy and exports along with lots of other stuff.

    Red Queen said;
    What we need is to stop seeing the government as the solution, which the Labour Party seems hellbent on continuing,

    Don’t you mean the National Socialist party. They are the ones in power at the moment and Key et al have said they will not do anything that will lose them votes. Never mind that they might gain some, but that’s normal behavior. People seldom act to make a gain but always act to stop a loss, which is the game that they are currently engaged in.
    Intriguing that actually.
    And RQ its is a long time cry. Dare I mention his name here but the Honorable W.R. Peter’s has been banging on about it for years. One of the few things he got right.

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  15. Doug (405 comments) says:

    Viking:
    We could compare our results with Australia’s. We have fallen how far behind them? From ahead of them in the late 60’s to 35% behind today. Stunning success, by Australia no less.

    http://www.businessspectator.com.au/bs.nsf/Article/Aussies-12-trillion-in-debt-Z53CV?OpenDocument&src=tnb

    A stunning success Australia 1.2 trillion in Debt 100.4% GDP
    Spending binge, fuelled most recently by the federal government’s First Home Owner Grant, means personal debt now totals 100.4 per cent of Australia’s annual GDP – one of the highest ratios in the developed world.

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  16. redqueen (342 comments) says:

    Viking,
    I entirely take your point, and agree, that National hasn’t done enough, and instead just sat around, while ACT has been having internal squabbles which keep it from really doing anything either. That is a sad state of affairs, which is irritating, and something which I would like resolved. But the DomPost article dealt with Labour’s issues, not with the failings of the current Government, and that was what was being discussed. While National seems determined not to steer the ship in any particular direction but forward, Labour has proposed loonier after loonier scheme. So while I may not be a promoter of National, they at least haven’t descended into proposing silly ideas that are the antithesis of what we should do. Better honest ninnies than dishonest loonies, sir!

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  17. Guy Fawkes (702 comments) says:

    Inflation is the real Economy killer. Over Leverage or dependence on debt is a country killer.

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  18. Countess (157 comments) says:

    What inflation ? Unless you have a system of wage- rent- price controls how are you going to get inflation lower?

    For a country with a high dependence on trade, overseas factors are impossible to factor out- not that they count say the price of oil increases when it suits them.

    Its funny that DPF wants MORE regulation , big government deciding what the price of a transaction between businesses and its customers should be ???

    Hello. Next they will be supporting a wage freeze…

    [DPF: Just when I thought you could not be stupider, you manage to show you are.

    Inflation is the change in the overall price level, not individual prices. Most people learn that at school.

    And of course one can get inflation lower - that is what monetary policy is about.]

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  19. Elijah Lineberry (306 comments) says:

    National’s Inflation Policy A Recipe For Disaster.

    Now there is a great topic for a blog post! – especially since they are in Government, are pumping funny money into the economy, have no vision, have no policies (beyond winning the next election) and are supported by the ACT party in this foolish destructiveness

    The only successful anti-inflation policy which should be followed would be massive cuts in Government spending on welfare, working for families, civil servants pay, roads, foreign aid, hospitals, schools and other wasteful, unnecessary expenditure whilst at the same time allowing a free market to operate by getting rid of silly compliance costs.

    http://www.nightcitytrader.blogspot.com

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  20. Anthony (736 comments) says:

    The government could start by removing the inequities in the tax system which exaggerate the effects of the high interest rates needed to attract money to NZ. For a start, we should stop letting foreigners who deposit money in NZ banks pay no tax on the interest in return for the banks paying a 2% approved issuer levy. This must only push up the exchange rate for any given interest rate.

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  21. CharlieBrown (789 comments) says:

    Simple economics… There are two main approaches to managing the economy, monetary policy and fiscal policy. Up untill 1999, fiscal policy was sound and so was monetary policy. Since then, fiscal policy has been attrocious (it still is under JK), therefore monetary policy is having to try and counteract the attrocious fiscal policy. To make it even worse, the social engineering over the last 10 years has been having negative effects on the economy.

    To blame the current monetary framework is short-sighted, ignorant of history, and just plain stupid. The best approach the government could take to stabilise prices and exchange rates would be to introduce sensible fiscal policies, eg, remove all tax advantages to property investments (by making other investments more attractive), allowing property supply to be more liquid by removing some stupid zoning regulations and red tape, and by borrowing less and encouraging saving.

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